In this article, you will learn…
- What entities are available for commercial and industrial development projects,
- How you can limit your risk when it comes to financing commercial real estate, and
- When to hire an attorney to discuss starting a business.
What Entities Are Available For Commercial And Industrial Development Projects? What Are The Best For Our Situation?
We have to look at each item specific to your situation. Most lenders are going to want two things:
- An individual entity, and
- A corporate entity.
Lenders will want an individual entity because it’s easier to foreclose against an individual than it is against a company. They want to have an individual listed on the loan and the guarantee almost in every instance, unless you are some major company.
You have to have your financing in place beforehand because they want to see that you were pre-approved by someone. They want to see a corporate entity that’s going to be on the loan and then guaranteed by an individual or individuals, depending on the situation.
When we talk about different types of commercial real estate loans for development, the pros and cons of each, the difference is basically whether you’re going to get the money from a lender. You can get a loan from a regular commercial lender or you can go to the SBA. Those are really the two types of loans available for commercial real estate.
One of the biggest issues with SBA loans or government loans is the timeframe. It’s a much longer process to get approved by the SBA because they’re taking on a big part of your risk. However, for a borrower, that’s a good thing. It usually allows for a lower interest rate and better terms with the SBA, whereas a private lender would just be quicker.
The terms with a private lender aren’t going to be as good as with the SBA. Private lenders typically have some sort of prepayment penalty because they have caps. Sometimes you have no choice, though, because the SBA has caps. Sometimes you aren’t going to be able to get it to work because you’ll need more than, say, $5 million. You can get what they call an SBA 7(a) loan, which can do a higher loan amount, but then it becomes more difficult to get the terms changed.
Can You Limit Your Risk When It Comes To Financing And Developing Commercial Or Industrial Real Estate?
You absolutely can limit your risk when it comes to financing and developing commercial or industrial real estate. There are limits specifically put into a guarantee that says you can only borrow a certain number of dollars.
Obviously, the lender can still foreclose and take that property, but they may be limited to just whatever they can get from the property. The property is the only asset that’s at risk, not the individual.
Some people aren’t able to limit it to the same effect, but they may still be able to limit how much money they can go after the individual for. That’s one of the ways we try to limit risk.
When You’re Starting A Business, At What Point In The Planning Process Is It Ideal To Hire An Experienced New York Business Law Attorney?
You would want to hire an experienced New York business law attorney at the very start of thinking about starting a business. One of the most important discussions you will have when it comes to forming a business is what entity you will choose. You’re going to choose an entity based on…
- Your circumstances,
- What you want to do,
- What you want to cover, and
- What you want to protect.
In New York, you can either be a sole proprietor or a corporation.
If you just had a shingle that you put a sign on and you filed with the county clerk where you reside, you could request a business certificate. That business certificate would say that you’re now going to be known as ABC and you’re going to sell whatever it might be. Being a sole proprietor is the least expensive, but also the least protected, way of setting up a business.
There are also corporations, of which there are different types. There are C-Chapter and S-Chapter corporations.
An S-Chapter corporation is what many small businesses start out using. This is because it’s what they call an S-Chapter and Flow Through, which means that the company acts and must act as a corporation, but the income that the corporation gets is not taxed twice. The income is only taxed as a flow through to the shareholders.
If one person sets up an S-Chapter corporation, then they’re the sole shareholder. If the company makes $100,000 that year and, after expenses, it comes down to $40,000, that $40,000 is a flow-through that goes right through to the sole proprietor. The sole proprietor would then only pay income taxes on the $40,000 as a personal tax, not the corporate tax.
If there are more than one shareholder, then that $40,000 would get divided into shares however the corporation has designated. If it was fifty-fifty, it would be split that way.
In essence, it’s a flow-through to the shareholders for tax purposes but, at the same time, it offers the protections of a corporation in the event that they get sued. If the corporation is sued, only the assets of the corporation are at risk and not the individual assets. Unless, of course, you’ve personally guaranteed things or you specifically did something wrong.
In other words, if you have a corporation, no matter what type you have, the idea is to try to insulate yourself and protect yourself from the third parties who may try to sue. You don’t want any third party to get any assets of yours as an individual. You want to limit it only to the assets of the business.
What can, unfortunately, happen is that the sole proprietor is going out and doing the work himself. If the sole proprietor, in the course of that work, makes a mistake that ends up burning down someone’s entire house, not only would the corporation be liable, but so would the individual. This is because the individual was the person who actually burned the house down.
If the corporation has employees, however, and one of the employees makes a mistake and burns a house down, then the corporation is liable but not the individual. This is one of the main reasons that people do incorporations.
LLCs, or Limited Liability Companies, are big in real estate right now to use as their entity. LLCs also act as a flow-through to prevent double tax. However, accountants will tell you that an LLC, when it comes to real estate, is a better vehicle for tax purposes than a S-Chapter corporation. This is because the shareholders can move around the losses and profits of the company without staying within the terms of their ownership interest.
For example, if we have an LLC and 50% is owned by Joe and 50% is owned by Harry, you would think that any profits would be split fifty-fifty on their income tax return. However, in this example, Harry happens to own another business where he’s got a tremendous amount of losses. So, Joe may tell Harry that he’s going to give him $400,000 for income tax purposes and then the LLC can write it off against your losses so less money goes to the IRS.
You might move money around in this way to limit your tax exposure. This is what LLCs are allowed to do, provided that by the time the corporation settles, these have evened out between the two parties.
So, these are just some things to discuss with your attorney when you’re first thinking about starting a business.
With the guidance of a skilled attorney for Real Estate Law Cases, you can have the peace of mind that comes with knowing that we’ll make it look easy.